By Karen Harris, Christophe De Mahieu and Karim Shariff, Partners, Bain & Co
The consequences for companies, investors and policymakers are profound. In a world where the real economy is dwarfed by the accumulated financial capital, real interest rates remain low and capital allocation grows inefficient. Bubbles grow as investors chase yield.
To navigate in this environment, both corporate and portfolio investors will need to make three fundamental adjustments in how they deploy capital.
First, rethink hurdle rates. Today’s CFOs must reexamine their most basic macroeconomic beliefs. Lowering hurdle rates too far has always been a danger. Now they risk leaving their required return on investment targets too high. Global companies maintain high margins through excellent capital discipline. But in a world of capital superabundance, an unwillingness to expand below old hurdle rates leads to stagnating top-line revenue growth.
Second, beware of bubble risks. In a world of capital superabundance, bubbles will grow bigger and last longer. Companies that mistake a 2- or 3-year trend for a permanent inflection in the market may deploy resources just in time to see the bottom fall out. To detect bubbles, companies will need deep, focused business knowledge and diligence capabilities that can distinguish between true sources of growth and speculative short-term influences.
Finally, manage the balance sheet. Capital superabundance will require even the most traditionally stable businesses to operate more like a hedge fund, by actively managing their mix of long and short positions across a portfolio of business activities to insulate from a volatile macroeconomic environment. Leading companies will actively use the balance sheet to stabilize and enhance their core business strategy.
The shift from capital scarcity to superabundance is creating new opportunities. One will be to widen investment channels to emerging markets in Asia, Latin America and Africa. Finding the right regional or in-country expertise by partnering or hiring will help companies and global investors penetrate deeper into these developing markets. Many of the most attractive growth opportunities across this decade will require patient capital. Financial and strategic investors who stretch out their time horizons to find diversification and solid returns will be the most likely to succeed.
In the world of capital superabundance, winners will be determined less by their financial capital resources and more on the basis of their ideas, insights, talent and innovation. Coming to grips with this new world will be an important precondition for achieving sustainable long-term growth.